University of California, Santa Barbara

University of California, Santa Barbara
Prepared by Coby Harmon University of California, Santa Barbara Westmont College Copyright ©2015 Pearson Education Inc. All rights reserved.

EXPLAIN WHAT A TRANSACTION IS Transaction Any event that has a financial impact on the business Can be measured reliably Provides information about an exchange Something given Something received Accounting records both sides of a transaction LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

Purchase fresh produce
EXPLAIN WHAT A TRANSACTION IS Transaction Examples Whole Foods Market, Inc. Purchase fresh produce Sell product Borrow money Repay a loan LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

DEFINE “ACCOUNT,” AND LIST AND DIFFERENTIATE BETWEEN DIFFERENT TYPES OF ACCOUNTS Assets Liabilities Stockholders’ Equity = + Account Record of all changes in a particular asset, liability, or stockholders’ equity during a period Basic summary device LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Assets Economic resources that provide a future benefit Money including bank account balances, paper currency, coins, certificates of deposit, and checks Cash Accounts Receivable Promise for future collection of cash from the sale of goods or providing services Promise for future collection of cash Customer signed note Interest rate Notes Receivable LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Assets Economic resources that provide a future benefit Inventory Goods the company sells to customers Prepaid Expenses Expenses paid in advance, such as insurance and rent Land Cost of land used in operations LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Equipment, Furniture, and Fixtures
Assets Economic resources that provide a future benefit Building Cost of buildings used in operations Cost of furniture, fixture, and equipment used in operations Includes heating and air conditioning, computers, and office furniture Depreciated Equipment, Furniture, and Fixtures LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Liabilities A liability is a debt Accounts Payable Promise to pay a debt Notes Payable Signed notes promising to pay a future amount Accrued Liabilities Liability for an expense not yet paid LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Stockholders’ (Owners’) Equity Owners’ claims to the assets of a corporation Common Stock Owners’ investment in the corporation through the ownership of stock Retained Earnings Net income (loss) earned over the company’s lifetime, minus dividends Dividends Distribution to stockholders Declared by board of directors LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Stockholders’ (Owners’) Equity Owners’ claims to the assets of a corporation Revenues Increase in stockholders’ equity from delivering goods or services to customers Expenses Decrease in stockholders’ equity due to the cost of operating the business LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Name two things that (1) increase Whole Foods Market, Inc.’s stockholders’ equity and (2) decrease Whole Foods Market, Inc.’s stockholders’ equity. Answer: (1) Increases in stockholders’ equity: Sale of stock and net income (revenue greater than expenses). (2) Decreases in stockholders’ equity: Dividends and net loss (expenses greater than revenue). Advance slide in presentation mode to reveal answers. LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

SHOW THE IMPACT OF BUSINESS TRANSACTIONS ON THE ACCOUNTING EQUATION Example: Freddy’s Auto Service, Inc. To illustrate the accounting for transactions, let’s assume Freddy Kish opened Freddy’s Auto Service, Inc., in April 2014. LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transaction 1. On April 1, Freddy Kish and a few friends invest $50,000 to open Freddy’s Auto Service, Inc., in return for common stock. 1. +50, ,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transaction 4. Freddy’s received $7,000 cash by providing services for customers. 1. +50, ,000 2. -40, ,000 3. +3,700 +3,700 4. +7,000 +7,000 Service revenue LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transaction 5. Freddy’s repairs a fleet of UPS delivery trucks, and UPS promises to pay Freddy’s $3,000 within one month. 1. +50, ,000 2. -40, ,000 3. +3,700 +3,700 4. +7,000 +7,000 5. +3,000 +3,000 Service revenue LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transaction 6. Freddy’s Auto Service, Inc., pays $2,700 for the following expenses: rent, $1,100; employee salaries, $1,200; and utilities, $400. 1. +50, ,000 2. -40, ,000 3. +3,700 +3,700 4. +7,000 +7,000 5. +3,000 +3,000 -2, ,100 - 1,200 - 400 Rent expense Salary expense Utilities expense LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transaction 7. Freddy’s pays $1,900 on account, which means to make a payment toward an account payable. 1. +50, ,000 2. -40, ,000 3. +3,700 +3,700 4. +7,000 +7,000 5. +3,000 +3,000 6. -2, ,700 7. -1,900 -1,900 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transaction 8. Freddy Kish, the major stockholder of Freddy’s Auto Service, paid $30,000 from his personal bank account to remodel his home. 1. +50, ,000 2. -40, ,000 3. +3,700 +3,700 4. +7,000 +7,000 5. +3,000 +3,000 6. -2,700 -2,700 7. -1,900 -1,900 No Entry LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transaction 9. In transaction 5, Freddy’s performed services for UPS on account. The business now collects $1,000 from UPS. 1. +50, ,000 2. -40, ,000 3. +3,700 +3,700 4. +7,000 +7,000 5. +3,000 +3,000 6. -2,700 -2,700 7. -1,900 -1,900 9. +1,000 -1,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transaction 10. Freddy’s receives $22,000 from the sale of land, which is the same amount that Freddy’s paid for the land. 1. +50, ,000 2. -40, ,000 3. +3,700 +3,700 4. +7,000 +7,000 5. +3,000 +3,000 6. -2,700 -2,700 7. -1,900 -1,900 9. +1,000 -1,000 , ,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transaction 11. Freddy’s Auto Service, Inc., declares a dividend and pays the stockholders $2,100 cash. 1. +50, ,000 2. -40, ,000 3. +3,700 +3,700 4. +7,000 +7,000 5. +3,000 +3,000 6. -2,700 -2,700 7. -1,900 -1,900 9. +1,000 -1,000 , ,000 ,100 -2,100 Dividends LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Dr. Luke opened a medical practice specializing in physical therapy. During the first month of operation (February), the business, titled Dr. Luke, Professional Corporation (P.C.), experienced several events. Requirement Analyze the effects of the following events on the accounting equation of the medical practice of Dr. Luke, P.C. LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Feb. 1 Dr. Luke invested $100,000 in the business in return for common stock.
LO 3 Advance slide in presentation mode to reveal answer Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Requirements Using the data from the transaction analysis of the medical practice of Dr. Luke, P.C., answer the following questions. How much are total assets? How much does the business expect to collect from patients? How much does the business owe in total? How much of the business’s assets does Luke really own? How much net income or net loss did the business experience during its first month of operations? LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

An Account can be illustrated in a T-Account form
The T-Account Record of increases and decreases in a specific asset, liability, equity, revenue, or expense element Debit = “Left” Credit = “Right” Account An Account can be illustrated in a T-Account form LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Increases and Decreases in the Accounts: The Rules of Debit and Credit
Exhibit 2-3 | Accounting Equation and the Rules of Debit and Credit The type of account determines how to record increases and decreases. LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Increases and Decreases in the Accounts: The Rules of Debit and Credit To illustrate, Freddy’s Auto Service, Inc., received $50,000 and issued (gave) stock. What is the effect on the accounts? Cash Common Stock Debit for increase, 50,000 Credit for increase, 50,000 Exhibit 2-4 | The Accounting Equation after Freddy’s Auto Service’s First Transaction LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Freddy’s’ second transaction is a $40,000 cash purchase of land. What is the effect on the accounts? Cash Common Stock Bal 50,000 Credit for decrease, 40,000 Bal 50,000 Bal 10,000 Exhibit 2-5 | The Accounting Equation after Freddy’s Auto Service’s First Two Transactions Land Debit for increase, 40,000 Bal 40,000 LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Additional Stockholders’ Equity Accounts: Revenues and Expenses Two categories of income statement accounts Revenues Increase in stockholders’ equity from delivering goods or services to customers Expenses Decrease in stockholders’ equity due to the cost of operating the business LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Additional Stockholders’ Equity Accounts: Revenues and Expenses Exhibit 2-6 | Expansion of the Accounting Equation + Common Stock Retained Earnings - Dividends Revenues Expenses Assets Liabilities Stockholders’ Equity LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

RECORD (JOURNALIZE AND POST) TRANSACTIONS IN THE BOOKS Journal Chronological record of transactions Three steps Specify each account affected by the transaction and classify by type Determine if each account is increased or decreased (debit or credit) Record in the journal LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Accounts and Explanations
RECORD (JOURNALIZE AND POST) TRANSACTIONS IN THE BOOKS Steps to journalize the first transaction of Freddy’s Auto Service Step 1 Business receives $50,000 cash and issues stock Step 2 Both Cash and Common Stock increase Step 3 Journalize the transaction: A B C D 1 Date Accounts and Explanations Debit Credit 2 Apr 1 3 4 Cash 50,000 Common Stock 50,000 Issued common stock. LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Individual asset accounts
Individual liability accounts Individual equity accounts Exhibit 2-8 | The Ledger (Asset, Liability, and Stockholders’ Equity Accounts) LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Accounts and Explanations Posting to the Accounts
Copying Information (Posting) from the Journal to the Ledger Exhibit 2-9 | Journal Entry and Posting to the Accounts A B C D 1 Date Accounts and Explanations Debit Credit 2 Apr 1 3 4 Cash 50,000 Common Stock 50,000 Issued common stock. Cash Common Stock Posting to the Accounts 50,000 50,000 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

The Flow of Accounting Data Transaction Occurs Transaction Analyzed Transaction Entered in the Journal Amounts Posted to the Ledger Accounts LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transactions from Freddy’s Auto Service (1) Received $50,000 cash and issued stock to the owners Assets = Liabilities + Stockholders’ Equity Accounting Equation + 50,000 + 50,000 A B C 1 2 Journal Entry Cash 50,000 Common Stock 50,000 Cash Common Stock Ledger Accounts (1) 50,000 (1) 50,000 Advance slide in presentation mode to reveal answers LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transactions from Freddy’s Auto Service (2) Paid $40,000 cash for land Assets = Liabilities + Stockholders’ Equity Accounting Equation + 40,000 - 40,000 A B C 1 2 Journal Entry Land 40,000 Cash 40,000 Cash Land Ledger Accounts (1) 50,000 (2) 40,000 (2) 40,000 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transactions from Freddy’s Auto Service (3) Purchased supplies for $3,700 on account Assets = Liabilities + Stockholders’ Equity Accounting Equation + 3,700 + 3,700 A B C 1 2 Journal Entry Supplies 3,700 Accounts Payable 3,700 Supplies Accounts Payable Ledger Accounts (3) 3,700 (3) 3,700 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transactions from Freddy’s Auto Service (4) Performed services for clients and received cash of $7,000 Assets = Liabilities + Stockholders’ Equity + Revenues Accounting Equation + 7,000 + 7,000 A B C 1 2 Journal Entry Cash 7,000 Service Revenue 7,000 Cash Service Revenue Ledger Accounts (1) 50,000 (2) 40,000 (4) 7,000 (4) 7,000 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transactions from Freddy’s Auto Service (5) Performed services for a customer on account, $3,000 Assets = Liabilities + Stockholders’ Equity + Revenues Accounting Equation + 3,000 + 3,000 A B C 1 2 Journal Entry Accounts Receivable 3,000 Service Revenue 3,000 Accounts Receivable Service Revenue Ledger Accounts (5) 3,000 (4) 7,000 (5) 3,000 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transactions from Freddy’s Auto Service (6) Paid cash expenses: rent, $1,100; employee salary, $1,200; utilities, $400 Assets = Liabilities + Stockholders’ Equity - Expenses Accounting Equation - 2,700 - 2,700 A B C 1 2 3 4 Journal Entry Rent Expense 1,100 Salary Expense 1,200 Utilities Expense 400 Cash 2,700 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transactions from Freddy’s Auto Service (6) Paid cash expenses: rent, $1,100; employee salary, $1,200; utilities, $400 A B C 1 2 3 4 Journal Entry Rent Expense 1,100 Salary Expense 1,200 Utilities Expense 400 Cash 2,700 Rent Expense Salary Expense Utilities Expense Cash (1) 50,000 (2) 40,000 (6) 1,100 (6) 1,200 (6) 400 (4) 7,000 (6) 2,700 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transactions from Freddy’s Auto Service (7) Paid $1,900 on the account payable created in transaction 3 Assets = Liabilities + Stockholders’ Equity Accounting Equation - 1,900 - 1,900 A B C 1 2 Journal Entry Accounts Payable 1,900 Cash 1,900 Cash Accounts Payable Ledger Accounts (1) 50,000 (2) 40,000 (7) 1,900 (3) 3,700 (4) 7,000 (6) 2,700 (7) 1,900 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transactions from Freddy’s Auto Service (9) Received $1,000 on account Assets = Liabilities + Stockholders’ Equity Accounting Equation + 1,000 - 1,000 A B C 1 2 Journal Entry Cash 1,000 Accounts Receivable 1,000 Cash Accounts Receivable Ledger Accounts (1) 50,000 (2) 40,000 (5) 3,000 (9) 1,000 (4) 7,000 (6) 2,700 (9) 1,000 (7) 1,900 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transactions from Freddy’s Auto Service (10) Sold land for cash at the land’s cost of $22,000 Assets = Liabilities + Stockholders’ Equity Accounting Equation + 22,000 - 22,000 A B C 1 2 Journal Entry Cash 22,000 Land 22,000 Cash Land Ledger Accounts (1) 50,000 (2) 40,000 (2) 40,000 (10) 22,000 (4) 7,000 (6) 2,700 (9) 1,000 (7) 1,900 (10) 22,000 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Transactions from Freddy’s Auto Service (11) Declared and paid a dividend of $2,100 to the stockholders Assets = Liabilities + Stockholders’ Equity - Dividends Accounting Equation - 2,100 - 2,100 A B C 1 2 Journal Entry Dividends 2,100 Cash 2,100 Cash Dividends Ledger Accounts (1) 50,000 (2) 40,000 (11) 2,100 (4) 7,000 (6) 2,700 (9) 1,000 (7) 1,900 (10) 22,000 (11) 2,100 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Architect Wendy Lim purchased supplies on account for $5,000. Later Wendy paid $1,400 on account. Journalize the two transactions on the books of Wendy Lim, architect. Account Debit Credit Supplies 5,000 Accounts Payable 5,000 Accounts Payable 1,400 Cash 1,400 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

Post the journal entries to T-accounts
Illustration Account Debit Credit Journal Entries Supplies 5,000 Accounts Payable 5,000 Accounts Payable 1,400 Cash 1,400 Cash Supplies Accounts Payable 1,400 5,000 1,400 5,000 LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

How much does the business owe?
Illustration Account Debit Credit Journal Entries Supplies 5,000 Accounts Payable 5,000 Accounts Payable 1,400 Cash 1,400 Cash Supplies Accounts Payable 1,400 5,000 1,400 5,000 Bal 3,600 How much does the business owe? LO 5 Copyright ©2015 Pearson Education Inc. All rights reserved.

CONSTRUCT AND USE A TRIAL BALANCE Trial Balance Lists all accounts with their balances Assets listed first, then liabilities and stockholders’ equity Shows that debits equal credits Usually prepared at the end of the period Facilitates preparation of the financial statements LO 6 Copyright ©2015 Pearson Education Inc. All rights reserved.

Analyzing Accounts Suppose Freddy’s Auto Service began May with cash of $1,000. During May, Freddy’s received cash of $8,000 and ended the month with a cash balance of $3,000. You can compute total cash payments by analyzing Freddy’s Cash account: Cash Beginning balance 1,000 Cash receipts 8,000 Cash payments 6,000 * Ending balance 3,000 * 1, , ,000 = 6,000 LO 6 Copyright ©2015 Pearson Education Inc. All rights reserved.

Analyzing Accounts You can compute either sales on account or cash collections on account by analyzing the Accounts Receivable account (using assumed amounts): Accounts Receivable Beginning balance 6,000 Sales on account 10,000 Collections on account 11,000 * Ending balance 5,000 * 6, , ,000 = 11,000 LO 6 Copyright ©2015 Pearson Education Inc. All rights reserved.

Analyzing Accounts You can determine how much you paid on account by analyzing Accounts Payable (using assumed amounts): Accounts Payable Beginning balance 9,000 Payments on account 4,000 * Purchases on account 6,000 Ending balance 11,000 * 9, , ,000 = 4,000 LO 6 Copyright ©2015 Pearson Education Inc. All rights reserved.

Correcting Accounting Errors
Missing account Trace each account from journal to ledger Divide out-of-balance amount by 2 Reversing debits and credits doubles the error Divide out-of-balance amount by 9 If an integer (no decimals), error may be a slide or transposition LO 6 Copyright ©2015 Pearson Education Inc. All rights reserved.

Analyzing Transactions Using Only T-Accounts Decisions often are made without a complete accounting system T-accounts allow managers to analyze transactions quickly LO 6 Copyright ©2015 Pearson Education Inc. All rights reserved.

Analyzing Transactions Using T-Accounts For example, the managers of Whole Foods Market, Inc., may consider borrowing $100,000 to buy equipment. To see how the two transactions affect Whole Foods Market, Inc., the manager can go directly to T-accounts. Borrow Buy Equipment Cash (a) 100,000 (b) 100,000 Equipment Note Payable (b) 100,000 (a) 100,000 LO 6 Copyright ©2015 Pearson Education Inc. All rights reserved.

This work is protected by United States copyright law and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials. Copyright ©2015 Pearson Education Inc. All rights reserved.

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